Austin Real Estate Market – Back to the Future

The serious decline in housing sales in many parts of the country is well documented. This downturn was preceded by several years of rising home prices in many areas. In some cases, prices rose beyond levels that were supported by local salaries, and were clearly not sustainable. The driving force that fueled the rise in home prices was the availability of low interest money. Easy availability of home purchase money, plus historically low interest rates, allowed the demand side of the market to build.

When buyers could expect 15% appreciation and get 6% interest rates, who would not be motivated to buy? Of course, high demand always drives up prices. And, high demand always drives up the supply of homes, as builders increase inventory in response to demand.

The flow of money for mortgages came from new and unregulated sources. In the not too distant past, government regulated entities, such as Fannie Mae, were the main buyers of mortgages from lenders. More recently, Wall Street investors entered the market for buying real estate loans. Alternative loans, interest-only loans, 100% loans, creative ARM’s, no-documentation, and other high risk products became commonplace. Some of these loans began with a low interest rate that the borrower barely qualified for, and then switched to a higher rate after a short time. In many cases, the borrowers did not understand the risk that they were taking.

For most of my experience in real estate, buyers usually put 5% – 20% down, with 28% of their income allowed for mortgage payment, and their income was fully documented. When we began to see 100% financing on contracts, we were a little concerned by the shortage of personal investment, or skin in the game, as they say. The underlying expectation was that the market value of the home would increase quickly, and the buyers would be covered, if they needed to sell. Home ownership became speculative.

Sub-prime, alternative, no-doc, and other high risk loans are not limited to low income or poor credit buyers, and are not always predatory. Often, very sophisticated borrowers chose to keep their cash and leverage the purchase. In all price ranges, the easy availability of low interest money fueled the demand for home ownership, as well as investment in rental property. Inevitably, the demand for homes led to price increases, and elevated inventories, as builders produced more homes. Then the cycle was broken.

What caused the break? Foreclosures. Investors realized that mortgage backed securities contained more risk than expected, and stopped buying them. Suddenly, lenders did not have this market for selling loans. Without the flow of funds for easy mortgages, demand for homes slowed down. Prices began to fall in many parts of the country, and oversupply conditions prevailed. This has created challenging conditions for many homebuilders.

Of course, there is variation in how markets will survive this. Some will fare better than others. To be sure, in Austin we are experiencing the effects of the reduction in demand for homes, but it is not devastating. Why?

First, the Austin market did not experience double digit appreciation during the past few years. The graph showing the relationship between new listings and sales reveals that during the years from 2001 to 2004, the market in Austin was somewhat soft. This was just after the Dot.com bust, in which high tech areas suffered a downturn. The median price of homes only rose by about 3.5% per year. You can see that inventory was high relative to sales, and that kept appreciation at modest levels.

From 2004 to 2007 the Austin market heated up, and we began to see strong demand coupled with low inventory, especially in the central areas. The median price of homes grew about 6.5% per year. Over the nine years shown on the graph, appreciation has been steady, but reasonable. Builders were able to meet much of the growing market, keeping supply in balance with demand. We avoided a boom. Home prices did not rise excessively, and now are not falling precipitously. And, in Austin, home prices are in line with local salaries.

Second, the real estate market always reflects the job market. In the Austin metro, approximately 20,000 new jobs were added during the past year. Unemployment is about 3.5%, a level that some would consider full employment. Retail outlets are opening at a fast clip – an indication of widespread employment. New companies are moving here and Austin companies are expanding. Jobs bring in people, and people buy homes. Even in good job markets, it is possible for homebuilders to swamp the market. However, this has not happened.

In Austin we are not immune to the effects of the “new” tighter restrictions for obtaining loans. For the next year, we will see a more balanced market than we had in 2006 and 2007. Sellers will have to consider the fundamentals to attract a buyer. They will need competitive pricing, excellent presentation, and top level marketing. Buyers will have to have a down payment, good credit, and proper income for their loan.

So, for the next few years, it’s back to the future for Austin real estate.

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